ABSTRACT
One of the interesting problems in the theory of commercial policy concerns the magnitude of the gains from trade, and the extent to which protective policies may reduce real income below its potential maximum and may account for differences in real income among nations. As is well known, for a country small enough that its terms of trade are unaffected by its commercial policy, the loss of real income due to protection can be divided into two elements – the consumption cost resulting from the distortion of prices facing consumers away from the prices ruling in the world market, which represent the social alternative opportunity costs of commodities to the country, and the production cost resulting from the distortion of prices facing producers away from world market prices, which represent the social benefits from producing alternative commodities. Previous analyses of the cost of protection have applied the apparatus of the Hicksian compensation tests to these elements in the cost of protection, and have derived expressions for the total cost of protection in terms of elasticities of (compensated) demand and supply; 1 these analyses in effect explore the implications for economic welfare of small departures from free trade. This chapter presents an alternative approach to the problem, one that works with an explicit social utility function and transformation curve and is therefore not restricted to small departures from free trade. The results are, on the other hand, limited by the specific character of the utility and transformation functions employed, though these functions are flexible enough to comprise a wide range of practical possibilities.
